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Jun 24, 2019
Article I Opinion I Technical indicators are bullish as stock market benchmarks attempt new highs
Lawrence G. McMillan
10-13 minutes
The
prospect of lower interest rates in Europe and the U.S. has driven the
stock market into a bullish stampede. And, now, overbought conditions
are beginning to appear.
However, from a broader perspective,
there is too much talk on financial TV about euphoria and how the rally
can’t last. That kind of talk raises the possibility of much higher
prices before a meaningful correction sets in. But those things are too
vague to measure; we will stick with our indicators, which are still
bullish.
The S&P 500 Index
SPX, -0.01%
broke out to a new all-time
high — and did it strongly, blasting through the old highs at
2,940-2,950 points. The Dow Jones Industrial Average
DJIA, +0.14%
is not far behind. The Nasdaq Composite Index
COMP, -0.11%
as well as the Invesco QQQ Trust exchange traded fund
QQQ, -0.10%
are a bit further behind,
although not much. But the broad-based small-caps, such as the Russell
2000
RUT, -0.69%
and a popular ETF based on it, the iShares Russell 2000
IWM, -0.77%
are way behind. (More about that later.)
The
question remains whether this increase is just going to be another
failed attempt at the highs or not. Most of these charts have obvious
triple tops (even SPX) and perhaps even quadruple tops (the Dow, for
example). Once again, we have arrived at the highs with a lot of
firepower already having been spent. As it turns out, the market
pullback in May was a correction — reloading for just this, an attempt
at new all-time highs. We’ll see if SPX can hold these new levels. The
entire May correction of just over 200 SPX points (which in its own
right was pretty fast — occurring in a mere month) has been completely
reversed in only 13 trading days.
There should now be support on
the SPX chart at 2,890-2,900 points, the area that was most recently
overcome as resistance. Below there, it’s a sharp drop down to major
support at 2,720-2,730 (the March and June lows).
There is no
formal resistance, since we are at all-time highs. In these situations,
we often rely on the +4σ “modified Bollinger Band” (mBB) as a sort of
resistance area. Well, we’ve already broken through there. SPX closed
above that band on June 20, and thus a new mBB sell signal will be
forthcoming. For the most part, these mBB signals have been successful.
(See SPX chart; red letters indicate a successful signal, while blue
letters are losing trades.)
The equity-only put-call
ratios remain strongly on buy signals. Whereas we saw heavy put buying
all through May and even into June, we now are seeing heavy call buying.
These ratios will remain on buy signals as long as they continue to
decline on their charts.
Market breadth was having trouble
gaining traction on this rally, but it has finally come around. Both
breadth oscillators are moving deeper into overbought territory, now
that SPX has broken out to new all-time highs. That is a good thing, in
that we want to see these oscillators in an overbought state when the
SPX is embarking on a new rallying phase. As I said, the breadth
oscillators were a little late getting into the game this time, but now
they are positive. It would take at least a couple of strong negative
breadth days to generate a sell signal from these levels.
There
are three indicators that we watch for negative divergences, especially
when the SPX is at or near new all-time highs: cumulative breadth, new
highs vs. new lows, and SPX versus the Russell 2000.
Cumulative
breadth using NYSE-based data made new all-time highs on three days last
week. In terms of “stocks only” data (usually the more realistic
measure), cumulative breadth is not yet at a new all-time high, but it’s
almost there. In other words, there is no negative divergence here.
New
highs are dominating new lows, in terms of all three data sets. The
weakest of the three is the Nasdaq, and the strongest is the NYSE-based
data (with “stocks only” in between). So this indicator, which is often
an early-warning system, shows no signs of bearishness at this time.
The
third measure — SPX versus RUT — is still a major negative concern.
Consider the accompanying chart. It is the price of IWM (the Russell
2000 ETF) divided by the price of SPY (SPDR S&P 500 ETF Trust). You
can see that the ratio between the two peaked in June 2018 and has been
declining ever since. Even this last broad rally in stocks has barely
lifted this ratio off its lows. In particular, since late February, SPY
has been trouncing IWM. Usually this is not a good thing, but it
sometimes takes a while to take effect.
This brings us to volatility. VIX
VIX, -0.13%
is hovering at somewhat higher
levels than in past summers, but as long as VIX is not trending upward,
it’s a positive sign for the stock market. The 200-day moving average
(MA) of VIX is still edging higher. So that intermediate-term concern is
still in place. But as long as VIX is closing below that 200-day MA,
there will not be a major correction in stocks. A close above that MA,
though, should be taken as a warning sign.
The construct of
volatility derivatives remains somewhat bullish, although not rampantly
so. The front-month VIX futures contract is now July, and it is trading
with a premium to VIX, as are the other futures contracts. Their term
structure slopes upward, although not very steeply (a concern,
perhaps?). Also, the CBOE Volatility Index term structure slopes
slightly upward (although VIX9D has probed above VIX several times in
recent days, even with SPX rallying strongly).
So, while not
bearish, the whole volatility complex is not as bullish as it has been.
This is unusual and should not be ignored. If VIX closes above 17 and/or
the term structures invert, those will be bearish signals.
In
summary, our indicators are mostly bullish, so we are bullish for the
short term as well. There are some concerns regarding overbought
conditions and perhaps volatility, but right now they have not
materialized into anything meaningful. However, given that the broad
market has failed at or near current levels several times in the past,
sell signals, if they arise, should be heeded.
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